By LEN WEISER-VARON

The U.S. Supreme Court’s June 26 opinion in Trinity Lutheran Church of Columbia, Inc. v. Comer, precluding states from discriminating against churches in at least some state financing programs, raises anew the question of whether states may, or are required to, provide tax-exempt conduit bond financing to churches and other sectarian institutions.  The Supreme Court’s decision further complicates an already complicated analysis of that question by bond counsel,  and in some instances may tip bond counsel’s answer in favor of green-lighting tax-exempt financing of some capital projects of sectarian institutions.

The First Amendment to the U.S. Constitution precludes Congress and, via the Fourteenth Amendment, states from legislating the establishment of religion (the “Establishment Clause”), or prohibiting the free exercise thereof (the “Free Exercise Clause”).  Under a line of Supreme Court cases that has been cast into doubt but never expressly repudiated by a majority of the U.S. Supreme Court, the Establishment Clause has been held to prohibit state financing of “pervasively sectarian” institutions, i.e. institutions that “are so ‘pervasively sectarian’ that secular activities cannot be separated from sectarian ones.” Roemer v. Board of Publ. Works of Maryland (1976).   Continue Reading Tax-Exempt Financing of Churches, Parochial Schools and Other Sectarian Institutions After Trinity Lutheran Church: Permitted? Required? Let us Pray for Answers

By LEN WEISER-VARON and BILL KANNEL

At the end of “The Candidate”, Robert Redford’s title character, having won, famously asks, “What do we do now?”

A similar question can be asked now that the federal district court in Puerto Rico has struck down the Puerto Rico Public Corporation Debt Enforcement and Recovery Act.

In a February 6, 2015 opinion, Judge Besosa rejected enough of Puerto Rico’s ripeness and standing arguments to reach the merits of the plaintiffs’  challenges to the validity of the Recovery Act.  As we had anticipated, Judge Besosa held that the Recovery Act is preempted by Section 903(1) of the federal Bankruptcy Code, which provides that “a State law prescribing a method of composition of indebtedness of [a] municipality may not bind any creditor that does not consent to such composition.”  The Recovery Act contains provisions that purport to permit changes to the debt obligations of eligible Puerto Rico public corporations without the consent of all affected debtholders. The court held that Section 903(1) applies to Puerto Rico, and that it not only invalidates those provisions of the Recovery Act that purport to bind non-consenting creditors, but preempts the Recovery Act entirely.

Puerto Rico enacted the Recovery Act because the federal Bankruptcy Code precludes Puerto Rico’s public corporations from availing themselves of Chapter 9 of the federal Bankruptcy Code to restructure their debts. Puerto Rico’s public officers are now asking themselves the Spanish version of Redford’s question: “Y ahora que hacemos?” Certain creditors of PREPA and other overleveraged Puerto Rico issuers may be asking variations of that question.

Some potential answers:

1)      The Recovery Act may yet recover. In addition to the ripeness and standing issues, Judge Besosa’s opinion rests on a textual analysis of Section 903(1), including the definition of the word “creditor” as used therein and elsewhere in the Bankruptcy Code and its applicability to creditors of an entity that is not a debtor in a federal proceeding. Puerto Rico is likely to appeal the federal district court’s ruling, both as to the ripeness and standing analysis and as to the applicability of Section 903 to Puerto Rico and the Recovery Act. The ruling is certainly a victory for the plaintiff bondholders and takes the Recovery Act off the table for the near future. In addition, Judge Besosa’s discussions of the contract clause and taking clause issues with the Recovery Act highlight the obstacles the Recovery Act has faced from the beginning as legislation that does not benefit from the federal bankruptcy power’s override of the contracts clause. Accordingly, a resurrected version of the Recovery Act, if any, would continue to face substantial legal challenges. But the Recovery Act, or something like it, will remain hovering in the background of any restructuring discussions during the pendency of the likely appeal.

2)      The invalidation of the Recovery Act, whether or not it proves permanent, eliminates the only existing process under which those public entities that would have been eligible to restructure under that legislation could do so over the objections of holdouts.  Both for Puerto Rico and for those creditors who believe that PREPA and/or certain other Puerto Rico issuers are incapable of sustaining their existing debt and must restructure, the invalidation of the Recovery Act may provide additional impetus to try to persuade the U.S. Congress to amend the Bankruptcy Code to authorize Puerto Rico to authorize its public corporations, or certain of its public corporations, to file for bankruptcy under Chapter 9. Such legislation was filed in the prior session of Congress and its viability may be somewhat enhanced by Judge Besosa’s ruling.

3)      While any Recovery Act appeal wends its way through the higher courts, and while any  legislation to amend the federal Bankruptcy Code seeks to wend its way through Congress, PREPA and PREPA’s creditors, and any other Puerto Rico issuers who seek debt relief and their creditors, will need to negotiate without a forum, without a final arbiter, and without the ability to impose a majority or supermajority consensus on holdouts. That process can be a messy and difficult one, but not necessarily an impossible one. In contrast to Robert Redford’s most recent movie, the working title for the as-yet-unfinished movie about Puerto Rico and its creditors remains All Is Not Lost.

 

 

 

BY LEN WEISER-VARON and BILL KANNEL

The latest swerve in the rollercoaster that is Puerto Rico public finance occurred on April 11 with the release of the Puerto Rico Supreme Court’s ruling striking down as unconstitutional the bulk of the territory’s teacher pension reform legislation.  The outcome of the case creates some disarray in the executive and legislative branches’ efforts to stabilize Puerto Rico’s finances, as well as in the Puerto Rico Supreme Court’s contracts clause jurisprudence.

We have previously discussed both the teacher pension reform litigation and the Puerto Rico Supreme Court’s prior ruling in the Hernandez case upholding the territory’s public employee pension reform legislation.  In the 5-4 Hernandez case, the dissents included strongly worded accusations that the majority had rubber-stamped the legislature’s conclusion that there were no less onerous alternatives to the  challenged impairments of the employee’s pension rights.   In the 5-3 teacher pension case, the majority went to the other extreme and concluded that the legislature and governor had acted unreasonably in enacting the legislation, because (according to the majority) the legislation failed to take into account the high number of accelerated teacher retirements the legislation would provoke, which (according to the majority) would further strain, rather than improve, the teacher pension system’s finances.

In other words, the court majority concluded that the teacher pension reform legislation did not promote the public purpose to which it was addressed.  As we have previously discussed, the “contracts clause” in the U.S. and Puerto Rico constitutions has been interpreted as permitting state action that impairs contracts if such action promotes a necessary public purpose and there are no less onerous means of achieving that public purpose.  Because the Puerto Rico Supreme Court concluded that the teacher pension reform legislation did not serve its stated public purpose of preserving the viability of the teacher pension system, it did not have to address whether there were less onerous means of achieving that purpose than the legislation’s benefit cutbacks and contribution increases.

In particular, the court referenced certain provisions of the legislation that preserved certain benefits for teachers retiring prior to a near-term cutoff date, economic studies presented by the teachers’ union regarding the impact of the early retirement of 7000 teachers, and an actuarial study forecasting the consequences of the early retirement of 5,000, 7000, 10,000 and 15,000 teachers, respectively.  The court also referenced testimony to the effect that approximately 4,100 teachers had contacted the pension system about early retirement since the legislation was enacted, and that 10,000 or more teachers would be eligible for early retirement.  The court interpreted the actuarial studies as showing that if such large-scale early retirements occurred, the pension fund would be depleted at an earlier date than if no legislation were enacted.  The court noted that the legislation had been enacted during a 6-day period and that the legislature had commissioned no studies about the early retirements the legislation might trigger or the impact of such early retirements on the system’s solvency.  The majority concluded that the teachers’ union had met its burden of proof that the challenged legislation, instead of increasing the system’s solvency, would leave it in a more precarious position.

The court upheld the legislation as applicable to teachers who began or begin service subsequent to its enactment, and also upheld certain cutbacks on system contributions to teachers’ health plans and annual Christmas bonuses to retired teachers, concluding that those benefits were not pension rights or contract rights.

It is unusual for a court, in a situation of fiscal crisis,  to hold that the other branches of government are effectively wrong about the financial effect of legislation being positive rather than negative.  There no doubt are genuine distinctions between the evidence presented in the Hernandez case and in the teachers’ pension case; it is also clear that there was a change in the receptiveness of certain of the court’s members to the government’s arguments regarding the necessity of the applicable pension reform.  To understand the difference in analysis and result, one may need to go no further than the majority opinion’s second paragraph, which states that “Teachers are the ones that mold the knowledge of the members of our society.  They are a fundamental piece of the educational system.”   A majority of the court appears to have credited the teachers’ presentation on this difficult public policy matter over the government’s.

Puerto Rico bondholders have been following this case for its credit implications as well as its legal implications.  The result may be a mixed bag from both perspectives.  From a credit perspective, the decision invalidates teacher pension reform that the Puerto Rico government has touted as an important component of its financial stabilization plan; on the other hand, the court invalidated the legislation on the stated grounds that the reform would make things worse, not better.  From a legal perspective, the court’s closer scrutiny of contract impairment may be somewhat heartening to bondholders concerned that Puerto Rico’s debt may be next on the impairment list.  Whether any comfort is warranted remains to be seen, but it seems less likely that the Puerto Rico Supreme Court would second-guess the financial efficacy of any future attempts to legislate debt restructuring.

By LEN WEISER-VARON and BILL KANNEL

Last Tuesday, Puerto Rico sold its much-ballyhooed $3.5 billion in non-investment grade general obligation bonds.  Two days later, two legislators in Puerto Rico’s Senate filed a bill which, if enacted, would permit insolvency filings by Puerto Rico’s public corporations in Puerto Rico’s territorial trial court.  The juxtaposition of the two events has some bond investors crying foul.  But though the timing of the insolvency bill must have Puerto Rico’s investor relations personnel swallowing ibuprofen, Puerto Rico itself is not a “public corporation” and the proposed legislation would not establish a process for an insolvency filing affecting the territory’s general obligation bonds.  (Although the legislation authorizes a bankruptcy-like process, the process is referred to in this post as “insolvency”  to distinguish it from the federal bankruptcy process.)

The proposed legislation is of greater interest to holders of bonds issued by Puerto Rico’s public corporation bond issuers.  To the extent the legislation responds to requests by one or more public corporations, it is not good news for bondholders, as it suggests that some of those public corporations may be actively considering an insolvency-related process.  However, press reports indicate that Puerto Rico’s Governor opposes enactment of this particular legislation.  Accordingly, the existence of the Senate bill, and its details, may deserve attention not so much because of any likelihood that such an insolvency process will be implemented in the short term, but rather as a case study in the legal complexity of any attempted restructuring of Puerto Rico’s governmental debt.

Whether legislation of the type represented by the Puerto Rico Senate bill, if enacted, would be constitutional would likely involve years of litigation following an attempt by any public corporation to avail itself of such protection as it provides.  As suggested in the bill’s preamble, Puerto Rico’s authority to create its own non-federal process to address insolvent public corporations is uncertain.  Puerto Rico’s instrumentalities are excluded from the definition of “municipality” under Chapter 9, which governs municipal bankruptcies.  Whether under the U.S. Constitution’s supremacy and bankruptcy clauses the existence of Chapter 9 preempts Puerto Rico’s ability to establish its own bankruptcy-like process for its public corporations, or whether Puerto Rico’s exclusion from Chapter 9  suggests that Congress did not intend such preemption, is the main constitutional question.  Further complicating the resolution of that question is Puerto Rico’s status as a federally-approved U.S. territory that has been recognized as akin to a “state” for at least some constitutional purposes by the U.S. Court of Appeals for the First Circuit.

If legislation of the type filed in Puerto Rico’s Senate were enacted, and if the constitutionality of such a non-federal insolvency process in Puerto Rico were ultimately upheld, such legislation by its terms limits a public corporation’s ability to restructure its debts.   The legislation precludes a “significant” impairment of the public corporation’s major contractual obligations unless it is reasonable and necessary to serve an important public purpose.  The legislation defines an “important public purpose” as including (somewhat perplexingly) the obligation to comply with existing contracts, but, perhaps more significantly, as including “the stability and continuity of essential public infrastructure, utilities and services.”   In other words,  the bill would create a “bankruptcy-lite” statute designed to permit approval of restructuring plans only to the extent they satisfy the federal constitutional test for impairment of contracts.  The “contracts clause” of the U.S. constitution has been judicially interpreted not as a prohibition on contract impairment but rather as a balancing test under which contracts may be impaired if there is sufficient public necessity for doing so and there are no less onerous means of addressing such public necessity .

The limits on what can be achieved under the proposed legislation are compelled by the fact that, if it were enacted, in contrast to Chapter 9 it would not be enacted under Congress’s constitutional power to provide a bankruptcy process.  Whereas the constitutionally-sanctioned federal bankruptcy act expressly contemplates certain judicially approved contract impairments to give a debtor a “fresh start”, a Puerto Rican public corporation insolvency statute not enacted pursuant to the constitutional bankruptcy provisions would need to comply with the anti-impairment provisions of the U.S. Constitution.  Accordingly, any plan under a Puerto Rico statute that impairs bondholder rights would be subject to challenge on whether the statute’s definition of “important public purpose”  correctly incorporates the federal constitutional balancing test for permissible contract impairment and, if so, whether that test has been properly applied in the context of any particular impairment by any particular bonding authority of particular bondholder rights.   This is an inefficient process relative to the federal bankruptcy statute, which provides a process for bankruptcy plan approval that obviates the need to address on a case by case basis whether an approved contract impairment is constitutional.

The bill introduced in Puerto Rico’s Senate reinforces a risk already faced by Puerto Rico bondholders that Puerto Rico may seek by direct legislation or by legislatively-established process to impair to the extent constitutionally permissible the contractual rights of bondholders of insolvent bonding authorities.  That risk is already playing itself out for a different class of Puerto Rico’s creditors, its public employees and teachers, in legislation imposing certain pension cuts and in court challenges to such legislation.  If there is good news for Puerto Rico’s public corporation bondholders in the specific legislation filed in the Puerto Rico Senate, it is that the insolvency process outlined in such legislation, unlike the federal bankruptcy statute,  lacks a “cramdown” provision and would require approval of any restructuring plan by 75% in amount of affected creditors.  In other words, any cutbacks in bondholder rights under the proposed legislation would, in most conceivable instances, require the consent of a substantial proportion of the bondholders.

By LEN WEISER-VARON and BILL KANNEL

Although Puerto Rico’s much-discussed sub-investment grade general obligation bond issue is not yet being marketed via an official preliminary official statement, it appears that a draft POS has been making the rounds.  The draft POS, dated February 28, 2014, has been posted on at least one website and has been referenced in Bloomberg news reports.

From a legal perspective, an initial review of the draft POS includes the following items of interest:

  • The bonds as offered will not be subject to acceleration upon default.  Accelerability is one of the items that had been mentioned on the buy-side wish list, as otherwise a payment default on a particular coupon or maturity would only entitle bondholders to institute remedial action for the payment of that particular coupon or maturity.
  • Unsurprisingly, there is a lengthy “Risk Factors” section, atypical for general obligation bonds but not for sub-investment grade bonds.
  • The draft POS indicates that Puerto Rico’s Secretary of the Treasury has exercised his new statutory authority to provide for application of New York law and to expressly agree to the jurisdiction of New York’s state and federal courts (as well as Puerto Rico’s) in any action relating to this issue of general obligation bonds. As we have previously discussed, this item was high up on the buy-side wish list.  However, the draft POS indicates that “no assurance can be given that any such litigation will be accepted by or, once accepted, be continued in a New York court or federal court in New York if the particular court determines by law that it does not have jurisdiction over the Commonwealth or that it should be removed to a court in Puerto Rico, as being more suitable on grounds of judicial fairness to the parties involved.” Furthermore, the draft POS states that “[a]lthough a judgment from a New York court should be given effect in Puerto Rico pursuant to the full faith and credit clause of the U.S. Constitution, such a judgment must meet certain minimum requirements before a Puerto Rico court will give it effect” and that “[t]here is no assurance that any judgment from a New York court would be given effect by a Puerto Rico court.”
  • The draft POS acknowledges the priority status of debt service payments on Puerto Rico’s “public debt” under Puerto Rico’s constitution, but indicates that “public policy considerations relating to the safety and well-being of the residents of the Commonwealth, as well as procedural matters, could result in delays in the judicial enforcement of this remedy, and in limitations on the effectiveness of such remedy” and that “the remedies available to bondholders are dependent on judicial actions, which are often subject to substantial discretion and delay.”
  • The draft POS notes the “clawback” provisions relating to Puerto Rico revenues assigned to Puerto Rico Highways and Transportation Authority (“Highways Authority”), Puerto Rico Infrastructure Financing Authority (“PRIFA”) and Puerto Rico Convention Center District Authority (“PRCCDA”), but states that the availability of such assigned revenues for debt service on the general obligation bonds “is subject to there being no other ‘available Commonwealth resources’” and that “[i]t is not certain what steps a general obligation bondholder would be required to take or what proof such bondholder would be required to produce to compel the diversion of such funds from any such instrumentality to the payment of public debt, or how the necessary available Commonwealth resources would be allocated between each such instrumentality.”
  • As required under SEC Rule 15c2-12, the draft POS discloses that “the Commonwealth has failed to file the Commonwealth’s Annual Financial Report before the May 1 deadline in three of the past five years.”  The draft POS states that “[a]lthough the Commonwealth has implemented certain mechanisms to ensure timely compliance with its continuing disclosure obligations, there is no assurance that the mechanisms put in place will be effective in ensuring timely compliance.”
  • There is no reference in the draft POS to the designation of purchasers’ counsel to represent prospective purchasers of the bonds in assessing the legal risks, legal opinions, continuing disclosure rights and other legal matters relating to this unusual offering. The funding of purchasers’ counsel by Puerto Rico or the underwriters has been requested by some prospective bondholders.

By LEN WEISER-VARON and BILL KANNEL

As reported by the Wall Street Journal today and by other sources, the authorizing legislation for Puerto Rico’s much anticipated $3.5 billion non investment grade general obligation issue has become hung up in Puerto Rico’s Senate over language included in the bill passed by the territory’s House of Representatives that would authorize Puerto Rico’s Treasury secretary to agree that disputes over such bonds would be governed by the laws of, and could be brought in, a jurisdiction other than Puerto Rico. New York is the jurisdiction and law bondholders are presumed to prefer.

There are three possible outcomes.  If the legislation is enacted in the House form and the Treasury secretary so agrees, Puerto Rico could eliminate any doubt over the ability of bondholders to litigate disputes over the new general obligation bonds in New York federal or state court.  If the legislation as enacted is stripped of the House language, there may be no choice of law or forum provision in the documentation governing the general obligation bonds, in which case, as we have previously discussed, it would remain open to bondholders to bring suit in New York state court (or for injunctive relief in New York federal court), although Puerto Rico could seek to contest New York’s jurisdiction.  If the legislature or the Treasury secretary insist on affirmative language in the general obligation bond documentation requiring suit on the bonds to be brought in Puerto Rico, bondholders, if they accepted such terms, would be bound to litigate in Puerto Rico.

Today’s Wall Street Journal article asserts that “the vast majority of Puerto Rico’s existing bonds are subject to the island’s local law and jurisdiction.”  We believe that may overstate the case as to the jurisdiction element.  A sample of offering documents for Puerto Rico’s outstanding general obligation bonds contains no mention of a Puerto Rico jurisdiction requirement, and the bond resolution for COFINA bonds, while specifying that Puerto Rico law governs, does not reference Puerto Rico jurisdiction.  Although express agreement on New York jurisdiction would be preferable from the perspective of bondholders, it is not a given that silence on the topic in the documentation for the upcoming general obligation bonds would concede exclusive Puerto Rico jurisdiction.

By LEN WEISER-VARON and BILL KANNEL

The Government Development Bank for Puerto Rico (GDB) hosted an unusual public conference call on October 31 to respond to legal questions raised by investors in bonds issued by the Puerto Rico Sales Tax Financing Corporation, better known by its Spanish acronym, COFINA.  During the one-hour call (which is available for replay on the GDB website), bond counsel and underwriters’ counsel made presentations explaining the rationales for legal opinions they delivered in connection with COFINA’s most recent bond issues, and responded to several written questions submitted by investors in advance of the call. Continue Reading Puerto Rico Supreme Court’s Deference to Legislature’s Determinations: A Double-Edged Sword for Puerto Rico Bondholders?

A series of alternative proposed Initiative Petitions were filed Thursday, August 7, with the Office of the Attorney General of Massachusetts (the “AGO”) seeking primarily to establish specified limits on operating margins achieved by many Massachusetts hospitals and on the compensation of the CEOs of such hospitals.  Details are described in the following Public Finance Alert:

http://www.mintz.com/newsletter/2013/Advisories/3289-0813-NAT-PF/index.html

By BILL KANNEL and ADRIENNE WALKER

Within days of Kevyn Orr’s appointment as Detroit’s Emergency Manager, a group of elected officials, union representatives, civil rights activist and clergy brought a lawsuit against Gov. Rick Snyder and Treasurer Andy Dillon in federal court, challenging the constitutionality of Public Act 436.  As previously posted, under Public Act 436, an emergency manager (an “EM”) has extraordinary powers over the municipality, including the power to break or modify union contracts; however, any plan implemented by an EM may not attempt to modify debt service payments on public debt. 

The Complaint asserts that Public Act 436 is an unconstitutional encroachment in the due process right of an elected, republic form of government.   The plaintiffs also contend that the new law establishes a “new form of government in Michigan” and citizens “will have effectively lost their right to vote”, which is in violation of the 1965 Voting Rights Act because it disenfranchises voters. 

A link to the Complaint may be found here.

By BILL KANNEL and ADRIENNE WALKER

This is a follow up to our recent blog post discussing then pending Michigan legislation known as the “Local Financial Stability and Choice Act” or Public Act 436 (the “Financial Stability Act”), which will replace Public Act 72 and overhaul Michigan’s emergency manager law.  On December 27, 2012, Michigan Gov. Rick Snyder signed the Financial Stability Act into law.   As described in the prior post, the Financial Stability Act requires that a local government experiencing a financial emergency select one of the following options to address such emergency:

a)     Consent agreement;

b)     Emergency manager;

c)      Neutral evaluation process (i.e., mediation with creditors); or

d)     Chapter 9 bankruptcy.

The Financial Stability Act will not become effective until March 28, 2013.   Until that time, Public Act 72 remains in effect